Arizona Legislature Exempts the Sale of Renewable Energy Credits from State Sales Tax

Affirming its commitment to the development of renewable energy resources, the Arizona legislature recently passed legislation exempting the sale and/or use of Renewable Energy Credits (generally referred as “RECs”) from Arizona’s transaction privilege tax, which operates similar to a sales tax. Given that Arizona’s state transaction privilege tax is over seven percent in most counties, and that city tack on an additional 2 to 3 percent tax, the decision to exempt the sale of RECs from a 10 percent tax is a significant development that should encourage the development of renewable energy in Arizona.

Arizona’s Renewable Energy Standard

In 2006 the Arizona Corporation Commission, which is the state agency that governs public utilities, enacted the Renewable Energy Standard and Tariff. This “RES Tariff,” which became effective in 2007, requires that by 2025, at least 15 percent of energy supplies come from eligible renewable energy, with smaller amounts required in earlier years.  Of the total renewable energy requirement, 30 percent must come from distributed energy renewable resources by 2025, again with smaller amounts required in earlier years.

A “distributed energy resource” is small-scale power generation technology used to provide an alternative or enhancement to the traditional electric power system and is located on the customer’s side of the power meter.  Rooftop or parking lot solar panel arrays are examples of a distributed energy resource, and can be contrasted with solar power plants operated by the utilities themselves.  Under the RES Tariff, 50 percent of the distributed energy resource must come from residential customer systems while the remaining 50 percent must come from non-residential, non-utility applications.

The RES Tariff allows public utilities to charge customers a tariff (fee) for the costs of implementing the RES Tariff.

Renewable Energy Credit Purchase Programs allow public utilities to provide incentives to customers that have an on-site distributed energy resource to supplement their energy needs.  The money used to fund these incentives comes from the RES Tariff fees that utilities collect from all retail customers.  The REC purchase program generally consists of two different types of incentives that are used to help defray the costs of constructing distributed energy renewable resources:  an up-front incentive, and a performance based incentive.  The up-front incentive is available for residential customers as well as small scale commercial projects.  The performance based incentive is available for larger commercial projects.

The up-front incentive pays customers a flat fee to help offset the cost of installing a distributive energy system.  The performance based incentive, which is used for larger commercial projects, pays the customer based on annual energy production from the distributive energy system.

Public utilities account for and receive credit for the amount of electricity generated from a distributed energy resource by the use of renewable energy credits–“RECs”.  One REC equals one kilowatt hour of electricity generated by an eligible renewable energy resource.

When a public utility pays either an up-front incentive or performance based incentive to customers for distributed energy renewable resources, the public utility earns RECs.  This incentive payment is a critical component in developing renewable energy resources.

Legislation Exempts the Sale RECs from State Sales Tax

RECs are created from the generation of electricity from renewable energy resources.  When the customer sells the REC to the utility, the customer is arguable earning gross income from the business activity of generating electricity.  Likewise, renewable energy resources are sometimes owned by a third party that finances construction of the facility for a property owner, maintains it, and sells electricity to the property owner.  This third party arrangement is popular in circumstances when the property owner is a government or non-profit entity that cannot directly benefit from the federal and state tax income tax credits that are available to help offset the costs of construction.  In this scenario, the third party sells the RECs to the public utility in exchange for the incentive payments.

In both circumstances, the entity that sells the RECs to the public utility in exchange for incentive payments is exposed to Arizona’s transaction privilege tax.  The concern is heightened when the third party sells the RECs because the third party  is also selling electricity to the property owner, which is taxable under Arizona’s transaction privilege tax.

Arizona’s legislature was rightly concerned that the sale of RECs in exchange for incentive payments could be subject to transaction privilege tax under the classification for utilities or retail sales.  For example, the Internal Revenue Service takes the position that incentive payments received from the sale of RECs is subject to income tax.  What the Arizona legislation does is it exempts the sale of RECs from transaction privilege tax under both the retail sales provision and the utilities provision.  It also provides that the purchase of RECs by the public utility is not subject to Arizona’s use tax.  So too, if the customer does not consume all of the electricity his renewable energy system generates, and he sells the excess back to the utility, those sales are also exempt from transaction privilege tax under this new legislation.  However, the legislation does not exempt the sale of RECs from income tax, which in Arizona is generally based on federal taxable income.


Over the last several years, the Arizona legislative has enacted a wide variety of tax exemptions and credits that help to reduce the cost of constructing renewable energy resources.  This recent legislation adds yet another incentive that will help fulfill its long term goal of having at least 15 percent of its energy generated from renewable energy resources.

Image: Katherine Welles via Shutterstock

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Mr. Metcalf is a partner at Lewis and Roca LLP. Among other areas, he practices in the areas of tax planning and tax controversy work. He regularly advises clients concerning state and local taxes, and represents clients who are involved in tax controversies with state, municipal or county tax collectors.

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